Wednesday, April 18, 2018

Canada holds rate, still cautious but looking to tighten

Canada's central bank left its benchmark target for the overnight rate at 1.25 percent, as expected, and confirmed it still expects to raise rates further by saying "higher interest rates will be warranted over time, although some monetary policy accommodation will still be needed to keep inflation on target."
The Bank of Canada (BOC), which has raised its rate three times since July 2017, said its governing council had noticed "some progress" in the dynamics of inflation and wage growth but as in its previous policy statement from March it added that it would "remain cautious with respect to future policy adjustments, guided by incoming data."
Growth in Canada was weaker than expected in the first quarter, but BOC expects growth to rebound in the second quarter, resulting in 2 percent average growth in the first half of this year.
The reason for slower growth in the first three months was due to a slowdown in exports, mainly from transportation bottlenecks, and lower activity in the housing market from new mortgage guidelines and other measures than pulled forward transactions to 2017.
BOC expects this weakness to be unwound as the year progresses and over the next three years, Canada's economy is seen operating slightly above its potential rate, supported not only by fiscal stimulus by the federal and provincial governments but also upward revisions to the country's output potential in its latest monetary policy report.
Exports are expected to strengthen due to foreign demand but BOC said both exports and investments "are being held back by ongoing competitiveness challenges and uncertainty about trade policies."
BOC forecast growth this year of 2.0 percent, down from its January forecast of 2.2 percent, and well below 2017's growth of 3.0 percent.
Growth in 2019 is seen rising to 2.1 percent, up from 1.6 percent previously forecast, and then easing to 1.8 percent in 2020.
On Tuesday the International Monetary Fund (IMF) lowered its forecast for Canada's growth this year to 2.1 percent from January's forecast of 2.3 percent. For 2019 the IMF sees 2.0 percent growth.
Canada's headline inflation rate rose to 2.2 percent in February from 1.7 percent in January and BOC said inflation is now expected to be higher than it forecast in January on higher gasoline prices and wage increases.
This year inflation is expected to average 2.3 percent, up from its previous forecast of 2.0 percent, and above the BOC's 2.0 percent target. In 2017 inflation averaged 1.6 percent.
In 2019 inflation is then seen easing to 2.1 percent and remaining at that level in 2020.

The Bank of Canada issued the following statement:

"The Bank of Canada today maintained its target for the overnight rate at 1 ¼ per cent. The Bank Rate is correspondingly 1 ½ per cent and the deposit rate is 1 per cent.

Inflation in Canada is close to 2 per cent as temporary factors that have been weighing on inflation have largely dissipated, as expected. Consistent with an economy operating with little slack, core measures of inflation have continued to edge up and are all now close to 2 per cent. The transitory impact of higher gasoline prices and recent minimum wage increases will likely cause inflation in 2018 to be modestly higher than the Bank expected in its January Monetary Policy Report (MPR), returning to the 2 per cent target for the rest of the projection horizon.

The global economy is on a modestly stronger track than forecast in January, with upward revisions to growth and potential output in a number of major advanced economies. The outlook for the U.S. economy has been further boosted by new government spending plans. However, escalating geopolitical and trade conflicts risk undermining the global expansion.

In Canada, GDP growth in the first quarter was weaker than the Bank had expected, but should rebound in the second quarter, resulting in 2 per cent average growth in the first half of 2018. The economy is projected to operate slightly above its potential over the next three years, with real GDP growth of about 2 per cent in both 2018 and 2019, and 1.8 per cent in 2020. This stronger profile for GDP incorporates new provincial and federal fiscal measures announced since January. It also reflects upward revisions to estimates of potential output growth, which suggest the Canadian economy has made some progress in building capacity.

Slower economic growth in the first quarter primarily reflects weakness in two areas. Housing markets responded to new mortgage guidelines and other policy measures by pulling forward transactions to late 2017. Exports also faltered, partly owing to transportation bottlenecks. Some of the weakness in housing and exports is expected to be unwound as 2018 progresses.

The Bank anticipates that Canadian exports will strengthen as foreign demand increases, but not sufficiently to recover the ground lost during recent quarters. Export growth is being increasingly limited by capacity constraints in some sectors. Continued gains in business investment should build additional capacity in those sectors and in the economy more generally. However, both exports and investment are being held back by ongoing competitiveness challenges and uncertainty about trade policies.

Growth in consumption remains robust, supported by strong labour income growth. Wages have continued to pick up as expected, even after factoring out recent minimum wage increases in Ontario and Alberta. The Bank will continue to assess labour market data for signs of remaining slack.

Some progress has been made on the key issues being watched closely by Governing Council, particularly the dynamics of inflation and wage growth. This progress reinforces Governing Council’s view that higher interest rates will be warranted over time, although some monetary policy accommodation will still be needed to keep inflation on target. The Bank will also continue to monitor the economy’s sensitivity to interest rate movements and the evolution of economic capacity. In this context, Governing Council will remain cautious with respect to future policy adjustments, guided by incoming data."